What is a Sinking Fund?
A sinking fund is a fund, which is created with a specific purpose such as
1. To redeem or repay a long term liability such as debenture, long term loans, etc.
2. To replace a wasting asset, such as a mine.
3. To replace an asset of depreciable nature such as plant & machinery, land & buildings, etc.
4. To renew a lease.
In case of sinking fund, every year a fixed sum of money is set aside for a definite period, which is invested at compound interest, so that at the end of the period the annual amounts, with interest accumulation, will be sufficient to repay the outstanding loan. In such cases, the amount set aside should not be debited to Profit and Loss Account, but to Profit and Loss Appropriation Account because in case of repayment of liability, the sum set aside is in the nature of allocation of profits and not in the form of charge against them.
Auditor’s Duty in auditing sinking fund
In case of sinking fund, the auditor should keep the following points in mind:
1. Auditor should see that a sinking fund is created as per the provisions of the Articles of Association.
2. He should be familiar with the terms and conditions regarding the creation of a sinking fund and see that they have been duly complied with.
3. He should check the charge made to profit towards the sinking fund account.
4. He should ensure that the amount of sinking fund is properly invested in easily marketable securities.
5. He should see that the interest on investment is received and accounted in the books of accounts as per the investment deed.
6. He should verify that the investment against sinking fund is clearly shown separately in the Balance Sheet.
7. He should see whether the sinking fund investments are sold on the due date and also that the profit or loss made on realization of investment is transferred to the Sinking Fund Accounts only and not to Profit and Loss Account.